Towards reducing fertiliser subsidy

India will remain a major consumer of chemical fertilisers; they are critical to raising farm output from limited and declining land resources for agriculture. Subsidies are not needed to promote fertiliser use any more, but only to maintain the balance between farm output prices and input costs. The policy dilemma on whether to opt for higher food subsidies or higher fertiliser subsidies continues.

Higher food subsidy may indeed also mean higher fertiliser subsidy. The challenge is also in untangling the benefits of subsidies between fertiliser production, farm production and feedstock supplies.

The idea of nutrient-based subsidy (NBS), under implementation since since last year, is also based on the possibility of using subsidy to influence balanced application of fertiliser. It may have also sharpened the focus on price incentives in the fertiliser industry, rather than merely subsidies. However, the need for balance between input costs and output prices in agriculture will require subsidies in some form or the other to support farm income.

Subsidy rationalisation, or rather, subsidy reduction in the case of fertilisers, has been on the policy agenda for about two decades. The quintessential dilemmas of fear of international markets, promise of self-reliance, need for raising food production by the small farmers made subsidies necessary.

OUTPUT CONCERNS

Even as they were tied up in the complex retention pricing formula, fertiliser subsidies were integral to the strategy of self-reliance in food production. In effect, the subsidies were also building industrial capacity.

However, the subsidy bill soon came to be seen as increasingly unsustainable. The possibility of more efficient direct payment of subsidies to the farmers seems to suggest that the raising domestic production capacity can be differentiated from fertiliser use in farming in the policy calculus.

The fiscal pressures have finally pushed the balance in favour of more affordable support for domestic production rather than merely raising production capacity at any cost.

Uncertainty over affordable level of subsidy and continuing controls on retail prices held back new investments in domestic fertiliser production. The availability of cheaper feedstock in the form of natural gas is not unlimited.

Domestic production of urea, the main chemical fertiliser used in the country, stagnated between 1999-00 and 2008-09, with some blips along the way. The production rose in the subsequent two years perhaps due to better availability of feedstock. Going forward, domestic production is likely to be influenced far more by availability of feedstock, particularly natural gas.

In the absence of reasonable supplies of this feedstock, subsidies will not lead to more production capacity. The stagnation in production capacity was a reflection of this reality.

The proposed coverage of urea under NBS now would be an important step towards greater conceptual clarity on the system of fertiliser subsidies. It is also culmination of many trends in the economy. The clarity is on the freedom to producers to fix the selling price of urea.

Although initially there will be a cap on retail price increase, the principle that retail prices may not be fixed by policy should provide clearer signals to new investments.

NUTRIENT-BASED POLICY

The NBS will still affect demand for urea and other fertilisers, but there may just be increased competition for a higher share of the fertiliser market.

NBS bill may also balloon high if the production cost of fertilisers rises, or if the distribution costs rise. NBS can also come under political pressure if farm incomes stagnate while input costs rise.

The rising share of imports to meet rising consumption of fertilisers is obviously a reflection of stagnant domestic output. There are many reported efforts by Indian firms to establish production capacity abroad. The flexibility in the new business environment that allows recourse to these options will make subsidy rationalisation easier than before. Capital can be raised more easily and technologies are available more easily.

SUBSIDY CHALLENGE

The many years of debate and discussion on fertiliser subsidies may have led to some rationalisation of the structure of industry in terms of type of feedstock used.

It has also sharpened attention on the need for more balanced use of nutrients. It has drawn attention to increasing the options of direct payment of subsidies to the farmers.

The budgeted level of fertiliser subsidy in 2011-12 is actually less than in the revised estimates for the previous year. But achieving this target when petroleum sector prices remain high would be difficult.

New ways of reducing subsidies are needed. Getting away from assuring a fixed rate of return on investments has been an important departure. The subsidy level now will be what is affordable.

But this is also the problem. There is no good rule for affordable level of subsidy. Greater competition in the fertiliser market is perhaps the only way by which the subsidy bill can be capped. There is a need for transition from tightly controlled market.

(The author is a Senior Research Counsellor, NCAER. blfeedback@thehindu.co.in )